Aviva Life & Pensions UK Limited

Transcription

1 Aviva Life & Pensions UK 2016 Solvency and Financial Condition Report

2 Contents Executive Summary A B C D E F Business and Performance System of Governance Risk Profile Valuation for Solvency Purposes Capital Management Appendices Page 1 of 118

3 Executive Summary Executive Summary The purpose of the Solvency and Financial Condition Report ( SFCR ) is to provide information about the capital position at 31 December 2016 of Aviva Life & Pensions UK ( the ) based on Solvency II requirements. The report sets out different aspects of the s business and performance, system of governance, risk profile, valuation methods used for solvency purposes and its capital management practices. Business and Performance The is a limited company incorporated and domiciled in the United ( UK ) which transacts life assurance and long-term savings business. The has both non-profit and with-profits funds and writes primarily pensions, bonds and protection business. The predominantly carries out its business in the UK and the Republic of Ireland. The reports to its chief operating decision makers using a non-gaap financial performance measure referred to as operating profit. The regards operating profit as an appropriate measure of underwriting performance. profit for the in 2016 was 557 million. The operating profit includes the impacts of Quota Share reinsurance arrangements with a fellow Group company, Aviva International Insurance ( AII ), and a subsidiary company, Aviva Annuity UK ( UKA ). Under the Quota Share reinsurance arrangements, 50% of a subset of the s non-profit business is reinsured to AII and 22.5% of the Long Term fund of UKA is reinsured to the. Section A of this report sets out further details about the s business structure, key operations, market position and financial performance over the reporting period, split by underwriting performance and investment performance. System of Governance The Board s responsibility includes ensuring that an appropriate system of governance is in place throughout the. To discharge this responsibility, the Board has established frameworks for risk management and internal control using a three lines of defence model and reserves to itself the setting of the s risk appetite. A strong system of governance throughout the aids effective decision-making and supports the achievement of the s objectives for the benefit of customers, shareholders and regulators. Section B of this report describes the system of governance in place throughout the by which the operations of the are overseen, directed, managed and controlled, and explains how it complies with the requirements of Solvency II. It describes the following key features: The roles and responsibilities of the Board, its sub-committees and key management committees, and delegation of authority to senior management; The remuneration policy, skills requirements and procedures for assessing fitness and propriety for senior management and key function holders; The s Risk Management Framework ( RMF ) and its codification through risk policies and business standards, which set out the risk strategy, appetite and framework and minimum requirements for the s operations. This includes the s approach to its Own Risk and Solvency Assessment ( ORSA ) and governance over its internal capital model for Solvency II; How the s business standards set out mandated control objectives and controls that mitigate operational risks faced by the, collectively providing the s framework of internal control; The role and responsibilities of the four key control functions Risk Management, Actuarial, Compliance and Internal Audit and how they are implemented within the ; The s outsourcing policy and information on important outsourced operational functions. Risk Profile As a long-term insurer, the accepts the risks inherent to its core business line of life insurance. Risks are diversified through the s scale, geographic spread, the variety of the products and services offered and the channels through which they are sold. Page 2 of 118

4 The receives premiums which are invested in order to maximise risk-adjusted returns, so that the can fulfil its promises to customers while providing a return to its shareholders. In doing so, the has a preference for retaining those risks which it believes it is capable of managing to generate a return. The types of risk to which the is exposed have not changed significantly over the year and remain credit, market, underwriting, liquidity and operational risks. Section C of this report further describes the risks to which the is exposed and how it measures, monitors, manages and mitigates these risks, including any changes in the year to the s risk exposures and specific risk mitigation actions taken. Valuation for Solvency Purposes Assets, technical provisions and other liabilities are valued in the s Solvency II Balance Sheet according to the Solvency II regulations. Assets and liabilities are valued at an amount for which they could be exchanged, transferred or settled by knowledgeable and willing third parties in an arms length transaction. The value of technical provisions under Solvency II is equal to the sum of a best estimate liability and a risk margin. Under Solvency II, the applies the transitional deduction to technical provisions. The transitional deduction has been approved by the PRA. The also applies a matching adjustment ( MA ) to its non-profit fund. The MA is an increase applied to the risk-free rate used to value insurance liabilities where the cash flows are relatively fixed (e.g. no future premiums or surrender risk) and are well matched to assets that are intended to be held to maturity and have cash flows that are also relatively fixed. At 31 December 2016, the s excess of assets over liabilities was 8,531 million on a Solvency II basis which is 4,153 million higher than the value under International Financial Reporting Standards ( IFRS ). The difference is primarily driven by the value of technical provisions. Section D of this report provides further description of the bases, methods and main assumptions used in the valuation of assets, technical provisions and other liabilities for each material asset/liability class. In addition, it also provides an explanation of the material differences between the IFRS and Solvency II bases of valuation. Capital Management The manages Own Funds in conjunction with solvency capital requirements. In the calculation of the SCR, the has chosen to implement a Partial Internal Model, defined as using a combination of Internal Model and Standard Formula approaches to calculate solvency capital requirements for different components of its business. In managing capital, the seeks on a consistent basis to: Match the profile of its assets and liabilities, taking into account the risks inherent in the business; Maintain sufficient, but not excessive, financial strength in accordance with risk appetite, to support new business growth and satisfy the requirements of the s regulators and other stakeholders giving the s customers assurance of its financial strength; Retain financial flexibility by maintaining strong liquidity; Allocate capital rigorously to support value adding growth and repatriate excess capital where appropriate. At 31 December 2016, the total eligible Own Funds to meet the Solvency Capital Requirement ( SCR ) was 7,099 million, consisting of excess of assets over liabilities of 8,531 million offset by a restriction in respect of the s ring fenced funds ( RFFs ) of 1,432 million. All of the s eligible Own Funds are represented by unrestricted tier 1 capital. The s SCR, which is calculated using a Partial Internal Model, at 31 December 2016 was 4,682 million. The overall surplus position was 2,417 million which translates to a regulatory cover ratio of 152%. Section E of this report further describes the objectives, policies and procedures employed by the for managing its Own Funds. The section also covers information on structure and quality of Own Funds and calculation of SCR, including information about the s Internal Model. Page 3 of 118

5 Section A Business and Performance In this chapter A.1 Business A.2 Underwriting performance A.3 Investment performance A.4 Any other information Page 4 of 118

6 Section A: Business and Performance The Business and Performance section of the report sets out the s business structure, key operations and financial performance over the reporting period. A.1 Business A.1.1 Business overview The, a limited company incorporated and domiciled in the UK, transacts life assurance and long-term savings business. The has both non-profit and with-profits funds and writes primarily pensions, bonds and protection business. The predominantly carries out its business in the UK and the Republic of Ireland. A.1.2 Organisational structure The following chart shows, in simplified form, the position of the within the legal organisational structure of the Aviva plc Group ( the Group ) as at 31 December Aviva plc is the holding company of the Group and is the ultimate parent undertaking of the. The immediate parent undertaking of the is Aviva Life Holdings UK ( UKLH ), a company incorporated in England. A complete list of participations in subsidiary undertakings and other related undertakings of the is shown in section F.3. Refer to section B for a detailed description of the system of governance in place within the and the Group. A.1.3 Significant events in the reporting period On 1 January 2016 the company entered into a Quota Share reinsurance agreement with AII to reinsure 50% of insurance liabilities in its non-profit fund, excluding the Irish branch and reinsurance accepted. The company s main insurance subsidiary, UKA, has a similar agreement with AII, and increased its reinsurance from 25% to 50% of its insurance liabilities on the same date. On 14 March 2016, 30 August 2016 and 28 November 2016 the subscribed for and was allotted 10 million, 5 million and 15 million ordinary of 1 each in the share capital of its subsidiary, Aviva Pension Trustees UK fully paid at par, for consideration of 10 million, 5 million and 15 million respectively. Page 5 of 118

7 On 9 November 2016 the Board approved the transfer of the whole of the long-term insurance business of UKA, to the through an insurance business transfer scheme under Part VII of the Financial Services and Markets Act 2000 (the Part VII Transfer ). The UK Court approved the scheme on 6 December 2016, with the transfer effected on 1 January A.1.4 Other information Qualifying holdings Qualifying holdings in the are held by UKLH, a limited company incorporated and domiciled in the UK, which holds of the s share capital. Supervisor The Group s and s Supervisor is the Prudential Regulation Authority ( PRA ), which is part of the Bank of England. Contact details for the PRA are as follows: Address 20 Moorgate, London, EC2R 6DA. Telephone number +44 (0) External auditor The s external auditor is PricewaterhouseCoopers LLP. Contact details are as follows: Address Central Square, 29 Wellington Street, Leeds, LS1 4DL. Telephone number +44 (0) A.2 Underwriting Performance profit measurement of performance from underwriting and other activities The Group reports to its chief operating decision makers using a financial performance measure referred to as operating profit. The Group and the regard operating profit as an appropriate measure of underwriting performance. profit is defined across the Group as IFRS profit before income taxes, excluding the following items: investment return variances and economic assumption changes on long-term business (included within non-operating costs in the table in section A.2.1), impairment of goodwill, associates, and joint ventures and other amounts expensed, amortisation and impairment of acquired value of in-force business, amortisation and impairment of other intangibles, profit or loss on the disposal and remeasurement of subsidiaries, joint ventures and associates, integration and restructuring costs and other items. Section A.2.1 shows a reconciliation of the operating profit to the income statement included in the s financial statements. While these excluded items are significant components in understanding and assessing the s financial performance, presentation of operating profit enhances the understanding and comparability of the underlying performance of the business by highlighting net income attributable to ongoing operations. Page 6 of 118

8 A.2.1 Performance from underwriting and other activities The table below presents the operating profit for the for the year ended 31 December 2016, as well as the reconciliation of operating profit to IFRS profit before tax as included in the s financial statements. FY16 m Gross written premiums 2,295 Premiums ceded to reinsurers (4,227) Net earned premiums (1,932) Fee and commission income 359 (1,573) Net investment income/(expense) 10,712 Income 9,139 Claims and benefits paid, net of recoveries from reinsurers (4,858) Change in insurance liabilities, net of reinsurance 6,052 Expenses attributed to investment contract provisions (5,681) Change in unallocated divisible surplus (238) Fee and commission expense (864) Other expenses (97) Finance costs (2,953) IFRS Profit before tax 500 Tax attributable to policyholders' returns (334) IFRS Profit before tax attributable to shareholders 166 Adjusted for non-operating items: Revaluation of investment in subsidiaries 722 Dividends received from subsidiaries (350) Other non-operating costs 19 profit before tax attributable to shareholders 557 The s operating profit is primarily driven by the profit recognised on two Quota Share reinsurance arrangements: On 1 January 2016 the company entered into a Quota Share reinsurance arrangement with a fellow Group company, AII. Under the terms of this Quota Share reinsurance 50% of a subset of the s non-profit fund is reinsured to AII. profit of 181 million has been recognised in respect of this arrangement during Further details of the impact on individual line items within the financial statements is provided in note 39 of the s financial statements. The also has a Quota Share reinsurance arrangement in place with its fully owned insurance subsidiary undertaking UKA. Under the terms of the Quota Share reinsurance, 22.5% of the Long Term Fund of UKA is reinsured to the. profit of 282 million has been recognised in respect of this arrangement during Further details of the impact on individual line items within the financial statements is provided in note 39 of the s financial statements. Items of income and expenses that do not directly relate to the Group s underwriting and investment activities are disclosed outside of operating profit. These are collectively referred to as adjusting items. The adjusting items are shown in the reconciliation from IFRS profit before tax to the operating profit in the table above. Further information on these items is provided in section A.4. A.2.2 Solvency II lines of business and products Detailed information on premiums, claims, expenses and changes in technical provisions by Solvency II line of business is presented in Quantitative Reporting Templates ( QRTs ) S and S (included in the Appendices in Section F.1). A summary of the information presented in these QRTs is shown below. Page 7 of 118

9 Health insurance Insurance with profit participation Index-linked and unit-linked insurance Other life insurance Life Reinsurance Total m m m m m m Gross premiums written , ,295 Premiums ceded to reinsurers (189) (9) (3,026) (1,002) (1) (4,227) Net premiums written (65) 256 (2,821) (1,932) Net claims incurred (29) (3,416) (419) (460) (534) (4,858) Changes in other technical provisions ,149 (16) (611) 2,934 Direct expenses incurred (15) (120) (794) (194) (58) (1,181) The sells a diverse range of products through its business. The principal products sold include pensions, annuities, protection and investment products. Some of the s insurance and investments products contain a discretionary participation feature, which is a contractual right to receive additional benefits as a supplement to guaranteed benefits. These are referred to as participating contracts. For business classified as non-participating investment business under IFRS the amounts received are treated as deposits under IFRS and an investment management fee is earned on the funds deposited. Consequently this business is not captured within IFRS net written premiums and therefore not included on the QRTs S Premiums, claims and expenses by line of business and S Premiums, claims and expenses by country. Non-participating investment business primarily consists of unit linked life and pensions business. A.3 Investment performance A.3.1 Measurement of investment performance Net investment income as disclosed in the s financial statements represents the s overall investment performance for both policyholders and shareholders. Net investment income consists of dividends, interest and rents receivable for the year, realised gains and losses and unrealised gains and losses on investments held at fair value. The s exposure to investment return varies according to the characteristics of the liability that the assets are held to support. For many types of long-term business, including unit-linked and participating funds, net investment income is broadly offset by corresponding changes in liabilities, limiting the net impact on profit. Therefore returns on policyholder, participating funds and shareholder investments are distinguished from one another: Policyholder assets are connected to unit-linked business, where the policyholder bears the investment risk on the assets in the unit-linked funds. Shareholder exposure to loss on policyholder assets is limited to the extent that income arising from asset management charges is based on the value of assets in the funds. Participating fund assets relate to a subset of insurance and investment contracts which contain a discretionary participation feature, which is a contractual right to receive additional benefits as a supplement to guaranteed benefits. Shareholder exposure to investment losses on participating funds is generally limited to the shareholder s participation in the fund. Shareholder assets are other assets held within the s business that are not backing unit-linked liabilities or participating funds. profit includes an expected investment return on financial investments backing shareholder funds and policyholder funds, with a consistent allowance for the corresponding expected movements in liabilities. Assets are invested in order to generate a return for both policyholders and shareholders. The financial strength of the and both current and future operating results and financial performance are, therefore, in part dependent on the quality and performance of the investment portfolios held by the. Page 8 of 118

10 The aim is to match appropriate investments to the nature of the underlying liabilities, whilst at the same time considering regulatory requirements, the level of risk inherent within different investments, and the desire to generate superior investment returns, where compatible with the stated strategy and risk appetite. A.3.2 Investment performance by asset class The following section summarises the s net investment income and provides an analysis of net investment income by fund type. Net Investment Income - Total Debt Securities m Equity Securities m Loans m Other financial investment m Investment property m Dividends ,536 Interest Net realised gains/(losses) 531 1, ,032 Net unrealised gains/(losses) 1,050 3, ,833 (149) 326 6,502 Rental income less expenses Other income less management charges (185) (165) Total 1,977 5, , ,712 Other m Total m The s expense for the year in respect of investment management fees amounted to 49 million. The following table provides an analysis of the s net investment income by policyholder, participating and shareholder exposures. Net Investment Income - Total Debt Securities m Equity Securities m Loans m Other financial investments m Investment property m Policyholder assets 602 4, , ,855 Participating assets 1,233 1, , ,752 Shareholder assets ,105 Total 1,977 5, , ,712 Other m Total m Net investment income primarily consists of realised and unrealised gains on debt securities, equity securities and unit trusts (included within other financial investments). Gains on debt securities reflect the returns on underlying indices (Government all stock indices of 7.0% and Corporate bond indices of 6.0%). The return reflects falling yields on gilts and investment grade bonds during Gains on equity securities reflect the returns on underlying indices (FTSE all share indices of 12%, S&P Europe indices of 16% and S&P World indices of 26%). Unit trusts are primarily invested in debt and equity funds. Consequently, gains on unit trusts reflect the returns on both debt and equity. Items within Other primarily consist of investment income in respect of participations and other subsidiaries. A.3.3 Investment performance: Other information Investments in securitisations Securitisation means a transaction or scheme, whereby the credit risk associated with an exposure or pool of exposures is tranched, having both of the following characteristics: payments in the transaction or scheme are dependent upon the performance of the exposure or pool of exposures; the subordination of tranches determines the distribution of losses during the ongoing life of the transaction or scheme. The holds investments in securitisation vehicles that are not originated by the in the form of debt securities. These securities consist of residential mortgage backed securities, commercial mortgage backed securities, asset backed securities, wrapped credit securities and collateralised loan obligation securities. Net investment income in the for the year in respect of these securitisations was 49 million. The key risks the s securitisations are exposed to are market risk and credit risk. The s risk management procedures in respect of market risk and credit risk are described in sections C.2.2. and C.3.2. Page 9 of 118

11 A.4 Any other information The s operating profit for the period was 557 million. The adjusting items reported below operating profit are outlined below. profit for the is based on expected investment returns on financial investments backing shareholder and policyholder funds over the period, with consistent allowance for the corresponding expected movements in liabilities. The expected rate of return is determined having regard to long term economic and market forecasts of investment return and asset classification. profit includes the effect of variances in experience for non-economic items, such as mortality, persistency and expenses, and the effect of changes in non-economic assumptions. Changes due to economic items, such as market value movement and interest rate changes which give rise to variances between actual and expected investment returns, and the impact of changes in economic assumptions on liabilities, are disclosed as non-operating items. Net investment income, as discussed in section A.3 Investment performance, includes both the operating and non-operating component of investment return. Other non-operating items primarily consist of fair value movements on the valuation of subsidiaries and dividends receivable from subsidiaries. profit is not a substitute for profit before income taxes or net income as determined in accordance with IFRS. The s definition of operating profit may differ from similar measures used by other companies, and may change over time. Page 10 of 118

12 Section B System of Governance In this chapter B.1 General information on the system of governance B.2 Fit and Proper policy B.3 Risk management system including the ORSA B.4 Internal control system B.5 Internal Audit function B.6 Actuarial function B.7 Outsourcing Page 11 of 118

13 Section B: System of Governance This section of the report sets out information regarding the System of Governance in place within the. Details of the structure of the 's administrative, management or supervisory body (defined as including the Board, subsidiary boards and Board sub-committees) are provided. The roles, responsibilities and governance of key functions (defined as the Risk, Compliance, Internal Audit and Actuarial functions) are also provided. Other components of the system of governance are also outlined, including the risk management system and internal control system implemented across the business. B.1 General information on the system of governance B.1.1 Overview of the s system of governance Role and responsibilities of the Board The Board s role is to be responsible for promoting the long-term success of the and for setting the strategy, against which management s performance is monitored. It sets the risk appetite and satisfies itself that financial controls and risk management systems are robust, whilst ensuring the business is adequately resourced. The Board is also responsible for setting the values and supporting the culture of the, and ensures appropriate dialogue with shareholders on strategy and remuneration. The Board s responsibility includes ensuring that an appropriate system of governance is in place. To discharge this responsibility, the Board has established frameworks for risk management and internal control using a three lines of defence model. A strong system of governance aids effective decision-making and supports the achievement of business objectives for the benefit of customers, shareholders and regulators. The Board comprises the Chairman, Chief Executive Officer, Chief Financial Officer and Independent Non-Executive Directors ( NEDs ). The Board s policy is to appoint and retain NEDs, who can apply their wider business knowledge and experiences to their oversight of the, and to review and refresh regularly the skills on the Board. The Board has established and delegated responsibilities to various committees to assist in its oversight of risk management and the approach to internal controls. There is alignment and communication between these committees and there is regular reporting to the Board. The full duties of the Board and of each of its committees are set out in each respective Terms of Reference. The Terms of Reference list both those items that are specifically reserved for decision by the Board and those matters that must be reported to the Board. The diagram illustrates the governance structure and a brief description of the main roles and responsibilities of each committee follows: The Risk Committee is responsible for assisting the Board in its oversight of risk, reviewing the s risk appetite and risk profile in relation to capital, liquidity and franchise, reviewing the effectiveness of the s Risk Management Framework, reviewing the methodology used in determining the s capital requirements, stress testing, ensuring due diligence appraisals are carried out on strategic or significant transactions, and monitoring the s regulatory requirements in relation to prudential matters, as appropriate. Page 12 of 118

14 The Conduct Committee is responsible for assisting the Board in its oversight of conduct issues. This oversight includes oversight of the s conduct framework including product design, live selling practices, claims practices, conduct oversight of third parties, the achievement of an appropriate conduct focused culture and the management of good and influential relationships with the regulators. It also sets and reviews the conduct and financial crime risk appetites and ensures that the reputational risk is consistent with the risk preference approved by the Board. The Investment Committee is responsible for assessing and approving investment strategy consistent with the risk appetite approved by the Board; considering investment matters that require Board approval (for example the investment into a new asset class); overseeing the relationship between the and its investment managers and monitoring investment performance. The Audit Committee is responsible for monitoring the integrity of the s financial statements and the effectiveness of the systems of internal control and for monitoring the effectiveness, performance, independence and objectivity of the internal and external auditors. There are also two other Board committees with specific purposes: With Profits Committee provides independent oversight and challenge to ensure that fairness and with-profits customers interests are appropriately considered in governance structures and decision making processes. Independent Governance Committee provides independent challenge in respect of the interests of relevant scheme members of workplace pensions. An effective delegated authority framework is an important part of good business governance. A set of transaction categories provide a comprehensive framework for assigning financial authorities to certain individuals consistently across the, with limits within each category to ensure they support effective and appropriate decision making. The three lines of defence model, and roles and responsibilities of key functions Roles and responsibilities for risk management are based around the three lines of defence model where employees are involved in the management and mitigation of risk. The roles of the three lines of defence each contribute to embedded risk management. The first line: management monitoring Management are responsible for the application of the RMF, for implementing and monitoring the operation of the system of internal control and for providing assurance to the Risk, Conduct, Investment and Audit Committees, and the Board. The second line: Risk Management, Compliance and Actuarial functions The Risk Management function is accountable for developing the RMF and for the quantitative and qualitative oversight and challenge of the identify, measure, manage, monitor and report ( IMMMR ) process. As the business responds to changing market conditions and customer needs, the Risk Management function regularly monitors the appropriateness of the s risk policies and the RMF to ensure they remain up to date. The Actuarial function is accountable for actuarial methodology, reporting to the relevant governing body on the adequacy of reserves and capital requirements, as well as underwriting and reinsurance arrangements. The Compliance function supports and advises the business on the identification, measurement and management of its regulatory, financial crime and conduct risks. It is also accountable for monitoring and reporting on the compliance risk profile. Refer to sections B.3.2, B.4.2 and B.6 for further details on the roles, responsibilities, authority, resources, independence and reporting lines of the Risk Management, Compliance and Actuarial functions respectively, and how their independence is ensured. The third line: Internal Audit This function provides independent and objective assessment on the robustness of the RMF and the appropriateness and effectiveness of internal control to the Audit, Conduct, Risk and Investment Committees, and the Board. Refer to section B.5 of this report for details on the roles, responsibilities, authority, resources, independence and reporting lines of the Internal Audit Function. Page 13 of 118

15 Implementation and assessment of adequacy of the system of governance The implements its RMF and system of internal controls and associated reporting procedures consistently throughout, via group-wide risk policies and business standards. To support an assessment of the effectiveness of the governance, internal control and risk management requirements, the Chief Executive Officer is required to certify annually that: there are sound risk management and internal control systems that are effective and fit for purpose in place across the business; and material existing or emerging risks within the business have been identified and assessed and the business operates in a manner which conforms to the minimum requirements outlined in the risk policies and business standards. Linked to this, the Chief Risk Officer must certify that: the Risk function has reviewed and challenged the process supporting the Chief Executive Officer s certification and is satisfied that it can provide reasonable assurance of the material accuracy and completeness of the Chief Executive Officer s assessment; and no material gaps exist in the RMF as it applies to the. Any material risks not previously identified, control weaknesses or non-compliance with the risk policies and business standards or local delegations of authority, must be highlighted as part of this process. Changes in the system of governance during 2016 There have been no material changes in the system of governance during the year. Terms of reference for all Board Committees were updated during 2016 and changes were approved by the Board. B.1.2 Remuneration Policy All staff are employed by a fellow subsidiary undertaking of Aviva plc, Aviva Employment Services, who make a management charge for services, including the provision of staff to the. The Group s reward principles and arrangements are designed to incentivise and reward employees for achieving stated business goals in a manner that is consistent with the s approach to sound and effective risk management. The Group s remuneration philosophy is based on four key principles which are outlined below: Align to the Group s purpose and strategy; Incentivise achievement of the Group s annual business plan and longer term strategic objectives of the business; Recognise leaders who achieve the required business results through living the Group values and behaviours; and Ensure risk based decision making and good governance. B Executive directors ( EDs ) The group-wide Remuneration Committee considers alignment between the strategy and the remuneration of its EDs to be critical. The Remuneration Policy provides market competitive remuneration, and incentivises EDs to achieve both the annual business plan and the longer-term strategic objectives of the business. Significant levels of deferral and an aggregate shareholding requirement align EDs interests with those of shareholders and aid retention of key personnel. As well as rewarding the achievement of objectives, variable remuneration can be zero if performance thresholds are not met. Remuneration of EDs includes a basic salary, variable components, a pension, benefits (including relocation and mobility) and a shareholding requirement. The variable components include an annual bonus and Long Term Incentive Plan ( LTIP ). The annual bonus is based on performance in the year. Targets are set annually and pay-out levels are determined by the Remuneration Committee based on performance against those targets. A significant proportion of any bonus awarded is deferred into which vest after three years. The LTIP vests subject to performance against two equally weighted performance measures, absolute return on equity ( ROE ) and relative total shareholder return ( TSR ) performance, which have been chosen to reflect shareholders longterm interests. Half of the LTIP vests if ROE exceeds 30% over the three-year performance period. The other half vests if the TSR is in the upper quintile when compared to a number of other external companies over the three year period. The Page 14 of 118

16 proportion of vested is lower if these performance measures are not met, and falls to zero when performance measures fall below pre-set targets. The Group did not operate any enhanced pension arrangements or early retirement schemes for key management during the reporting period. B NEDs NEDs receive a basic annual fee in respect of their Board duties. Further fees are paid for membership and, where appropriate, chairmanship of Board committees. The Chairman receives a fixed annual fee. Fees are reviewed annually taking into account market data and trends and the scope of specific Board duties. The Chairman and NEDs do not participate in any incentive or performance plans or pension arrangements and do not receive an expense allowance. B Employees Remuneration arrangements for employees that are not EDs take account of the seniority and nature of the role, individual performance and local market practice. The aim is to provide employees with remuneration packages that are clear and simple to understand, transparent, consistent and fair. Remuneration includes a basic salary, variable components and a pension. Variable payments are discretionary and fully flexible as opposed to a contractual entitlement, and there is a possibility of zero awards being made should the performance of the Group and/or individuals require this. Individual awards are based on a calibrated assessment of performance of individuals relative to peers. The remuneration of employees in the Risk Management function (including Compliance and the Actuarial function) and Internal Audit is determined independently of the financial results of the business areas they oversee. This reinforces the independence of these functions. B Material transactions with shareholders and persons exercising significant influence during the period Key management personnel may from time to time purchase insurance, savings, asset management or annuity products marketed by Group companies on equivalent terms to all employees of the Group. Any transactions with key management personnel deemed to be significant either by size or in the context of their individual financial positions have been conducted on an arms-length basis. Additional information on the material transactions with the s shareholder is included within Note 38 Related party transactions of the s financial statements. B.2 Fit and Proper policy The Group has the following policies in place to ensure that individuals acting on behalf of the are both fit and proper in line with the PRA s Fit and Proper requirements for individuals subject to the Senior Insurance Manager Regime and the Financial Conduct Authority s ( FCA s) requirements for Approved Persons: Fit - As part of recruitment and employee screening, an individual s career history will be assessed and validated to establish whether an individual s skills and knowledge are appropriately matched to the role. Proper checks are in place to ensure that an individual is honest, of good reputation, has integrity and is financially sound. The governance over the fitness and propriety of individuals spans across the employee lifecycle including recruitment, performance management and training. To ensure the Group protects itself against employing individuals who potentially could threaten its people, customers, properties, facilities or reputation, the majority of Fit and Proper activities take place within recruitment and more specifically in pre-employment screening. To support the recruitment activity for all staff across the Group, a policy to apply a minimum set of basic screening requirements has been agreed and implemented. Additional enhanced screening requirements and ongoing Fit and Proper requirements are also applied for individuals who fall within the following categories, as required by Solvency II requirements: Persons running the undertaking; Administrative, management or supervisory body; and Persons responsible for key functions. Page 15 of 118

17 For persons responsible for running the undertaking or responsible for key functions this assessment must consider their allocated responsibilities and skills and experience across a skills matrix covering the following areas: Insurance and financial markets; Business strategy and business models; System of governance; Financial and actuarial analysis; and Regulatory framework and requirements. The group-wide Nomination Committee identifies the skills and experience that it would like to have at Board level. These requirements are set out in a comprehensive skills matrix where Board members are asked via an online questionnaire to self-assess their experience and skills each year. The Skills Matrix is integral to the Committee s planning, discussions for developing further the Board s succession plans and commitment to Board diversity. Additionally, it is an essential tool to review and reflect on the skills that individual directors currently possess and ascertain areas in which training and development can be strengthened. Prior to appointing an individual into a key function role, checks take place to ensure that the relevant skills and experience have been identified and agreed for the role. This is achieved by engaging with both internal and external subject matter experts in each specialism to define the skills and experience required for each key function role. In all cases local business subject matter experts are engaged to ensure that all skills and experience requirements have been identified, including any specific qualifications required to carry out the role. These individual key function role skills and experience requirements and qualifications, where applicable, are captured within individual role descriptions for each role. Compliance with the initial and ongoing Fit and Proper minimum requirements is reported as part of the People Business Standard attestation by the People Director on behalf of the Chief Executive Officer to the Group People function. B.3 Risk management system including the ORSA B.3.1 Overall risk management system: strategies, processes and reporting procedures The RMF forms an integral part of the management and Board processes and decision-making framework across the. The key elements of this framework comprise risk appetite; risk governance, including risk policies and business standards; and the processes used to IMMMR risks, including the use of the s risk models and stress and scenario testing. To promote a consistent and rigorous approach to risk management across all parts of the business, there is a set of risk policies and business standards which set out the risk strategy, appetite, and minimum requirements for the s operations. On a semi-annual basis the Chief Executive Officer and Chief Risk Officer sign-off compliance with these policies and standards, providing assurance to the relevant oversight committees that there is a consistent framework for managing the business and the associated risks. For the purposes of risk identification and measurement, risks are usually grouped by risk type: credit, market, liquidity, underwriting and operational risk. Risks falling within these types may affect a number of metrics including those relating to balance sheet strength, liquidity and profit. They may also affect the performance of the products delivered to customers and the service to customers and distributors, which can be categorised as risks to the brand and reputation or as conduct risk. A regular top-down risk assessment and reporting process is facilitated by the Risk Management function. This includes the consideration of emerging risks and is supported by deeper thematic reviews. This, together with the risk and control self assessment ( RCSA ) process, are the main processes used to IMMMR risks. They are run separately but are complementary. The RCSA process is run by the first line, with challenge by the Risk Management function. It focuses on operational risks, which are recorded on icare, the s risk management system. Risk models are an important tool in the measurement of risks and are used to support the monitoring of the risk profile and in the consideration of the risk management actions available. A range of stress tests are carried out (where one risk factor, such as equity returns, is assumed to vary) and scenario tests (where combinations of risk factors are assumed to vary) to evaluate their impact on the business and the management actions available to respond to the conditions envisaged. Page 16 of 118

18 The Risk Management function is accountable for quantitative and qualitative oversight and challenge of the IMMMR process and for developing the RMF. Internal Audit provides an independent assessment of the risk framework and internal control processes. Board oversight of risk and risk management across the is maintained on a regular basis through the Risk, Conduct and Investment Committees. The Board has overall responsibility for determining risk appetite, which is an expression of the risk the business is willing to take. Risk appetite is set for capital and liquidity. Economic capital risk appetites are also set for each risk type, calculated on the basis of the Solvency II balance sheet. The position against risk appetite is monitored and reported to the Board on a regular basis. Risk preferences, being qualitative statements that express the risks that the seeks to avoid or minimize, are also set by the Board. Long-term sustainability depends upon the protection of franchise value and good customer relationships. As such, there is a risk preference that the will not accept risks that materially impair its reputation and requires that customers are always treated with integrity. Reporting of risks is provided to Board Committees and the Board by management, alongside Risk and Audit opinions. The Board has set clear expectations that reporting must present an accurate, clear and timely picture of existing and emerging issues, risk exposures and risk management activities and provide demonstrable evidence that the is managing its risks. Under Solvency II, the Internal Model must be embedded at the heart of risk and capital evaluation and its outputs must be used as a key part of a wide range of business and strategic decisions. As well as being a Solvency II requirement, this makes sense from a business perspective using a model which reflects the actual risk profile of the business drives more informed decisions. An annual Business Use Assessment process takes place which facilitates embedding and evidencing of the use of risk management and economic capital in decision making. It is recognised that it is important to have an appropriate risk culture ( tone from the top ). An appropriate culture includes the effective management of exposures, adequate resourcing, effective communication, malpractice reporting, a business ethics code that is annually signed up to by employees, and a commitment to integrity, ethical behaviour and compliance. A risk and control goal is set for senior management as part of the annual bonus plan to help drive and reward effective risk management and a robust control environment. This is assessed on an annual basis by the Group Risk Management function. B.3.2 Risk management function The Risk Management function is responsible for the design and implementation of the risk management system, and the design and independent validation of economic capital models requiring regulatory approval. The Risk Management function reports to the board on material risks identified, together with any other specific areas of risk requested by the board, and assists the board and management in the effective operation of the risk management system through the provision of specialist analysis and quality reviews, an aggregated view of the risk profile, and an assessment of the key risks associated with the business s strategy, major projects, strategic investments and other key decisions. The Risk Management function has authority to review all areas of the business and has full, free and unrestricted access to all activities, records, property and personnel necessary to complete its work. The scope of Risk s activities extends to all legal entities, joint ventures, partnerships, outsourcing and reinsurance arrangements. The Risk Management function operates as part of the Global Risk function, which includes the Actuarial and Compliance functions as well as Risk Management. Further information on the Actuarial and Compliance functions is set out in sections B.6 and B.4.2 respectively. B.3.3 Integration of risk management into the decision making processes Under Solvency II, the Internal Model must be embedded at the heart of risk and capital evaluation and its outputs must be used as a key part of a wide range of business and strategic decisions. As well as being a Solvency II requirement, this makes sense from a business perspective - using a model which reflects the actual risk profile of the business drives more informed decisions. An annual Business Use Assessment process takes place which facilitates embedding and evidencing of the use of risk management and economic capital in decision making. All key decisions must have the support of the Risk Management function before proceeding and the Chief Risk Officer has the power of veto. Page 17 of 118

19 B.3.4 ORSA The ORSA Report is the outcome of the combined processes and procedures (collectively ORSA processes) in place to manage and assess the risk and solvency position of the. The goal of the ORSA is to provide a continuous and forward-looking assessment of the short-term and long-term risks that the faces, or may face, ensuring that solvency requirements are met at all times. The ORSA processes comprise a number of elements of the RMF which are embedded in the business through the requirements of supporting risk policies and business standards around strategy, planning, capital management, stress and scenario testing and use of economic capital in decision making. In combination, these elements create a holistic overview of the elements of risk that may impact the, and which should be taken into account by management in day-to-day decision-making, in particular through the use of economic capital, and ensures risk and capital management are connected. The ORSA Report articulates the Board s formal view of the capital the needs to hold, given the risks currently faced by the business and how these might evolve over time, in line with delivery of the business strategy. It summarises a high level description of the key components of the underlying ORSA processes and the key outcomes from these processes. Consistent with the three lines of defence model, first-line management is responsible for the implementation of the majority of the underlying ORSA processes. The output from the ORSA processes is reported to the Board and the Board Risk Committee regularly during the year. The ORSA (Supervisory) Report is produced annually, as well as an interim ORSA update following the strategy refresh. The Chief Risk Officer is responsible for producing the ORSA Report which is reviewed and approved by the Risk Committee and the Board. The Board has approved that for the purpose of ORSA, capital resources and requirements are measured on the basis of Solvency II requirements for determining Solvency II Own Funds and SCR. Economic capital (as a risk based capital measure) is embedded at the heart of the s risk and capital evaluation and is used as a key input to a wide range of business and strategic decisions. The RMF, supported by risk policies and business standards, sets out the areas where businesses are expected to use economic capital management information as part of their decision-making and risk management processes. This ensures that requirements to use economic capital are embedded within the instructions of how the relevant processes (for example asset liability management or strategy and planning) are to be performed. Economic capital is calculated using the s Partial Internal Model. B.3.5 Governance over the Internal Model The Solvency II Internal Model Governance and Data Governance business standards and associated guidance, manuals, logs and reports are part of the overall RMF. These combine to ensure that the s businesses operate within a controlled environment when developing methodologies and assumptions, and when running processes and systems. The appropriateness of the s Internal Model is tested and confirmed by model validation, review and challenge, weakness and limitation management and general change control processes. In aggregate, these tests ensure there is a robust governance framework to support the use of the Internal Model in both a production environment and during model development or change. The Board is responsible for approving any Internal Model changes before submission to the College of Supervisors for approval. It is anticipated that there will be one model change application a year (around June each year). The quarterly model change reports and supporting evidence provide the required information to support Board Risk Committee and the College of Supervisors approval. The Chief Risk Officer is the ultimate Internal Model Owner. In practice the day to day responsibilities are delegated to the Chief Risk Actuary, as he has the accountability to give assurance to the Board that the Internal Model is appropriate for use on an ongoing basis; adequately reflects the business s risk profile; takes into account new information as it becomes available and works effectively. This enables the Board to conclude whether the Internal Model is fit for purpose whilst also ensuring it is used to provide information for important strategic and business decisions; capital management; business planning; risk mitigation; investment allocation and product development. The Internal Model Independent Validation Review (refer to the section below for further details) also provides an opinion to the Board on whether the Internal Model is suitably accurate and fit for purpose, and whether or not its approval is Page 18 of 118